Here’s the hard truth. Successful labels aren’t built on creative talent alone. There are hundreds of designers, just like you, who are looking to turn their passion into a profitable venture. But the successful ones understand that they also need to think like an entrepreneur and behave like a business. How do you know if your operation is on that path? By looking at your bottom line, also known as profits.
The Investopdia defines profit as, ‘a financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity. Any profit that is gained goes to the business’s owners, who may or may not decide to spend it on the business.’ Having some money left over after expenses is always great, but knowing why you’re profitable shows you parts of your business that are doing well and the ones that could be haemorrhaging your coffers. It’s definitely a vast topic but we’ll start off bite-size with a few terminologies and unproblematic equations that will help you know if you’re making bank.
Net Profit Margin
Also known as ‘profit margin’, this is the aerial view of the money you get to take home after you’ve factored in the costs.
Profit = Sales – Costs and Expenses
For example, if you’re selling a handbag for Ksh20,000 and it cost you Ksh15,000 to make, the profit would be Ksh5,000 and the profit margin would be 25%.
Gross Profit Margin
Now you want to get a closer look at your product’s financial success and viability once you’ve taken out direct costs such as labour, overheads and materials. Note: this doesn’t include general operational expenses. The higher the percentage, the more money you’ll have to cover other obligations and costs the label may have.
Gross Profit = Sales Revenue – Direct Cost
For Example: your Hat label sold Ksh4 million in revenue for 2016 and the cost of the direct labour and materials came to Ksh2 million. Therefore, your Gross profit would be Ksh2 million whereas your Gross Profit Margin (GPM) would be 50%. That’s 50 percent of the revenue that you get to keep after direct costs. However, you shouldn’t panic if the percentage is low. It could mean that you just have to make enough sales to cover your expenses. If the GPM drops annually, you may want to either raise the price of your product or drop your direct costs.
Average Order Value
Simply put, this tells you the amount of money you’re making per order. It looks at an average amount of orders in a specific span of time to determine the worth of your product. Having this kind of information lets you know what consumers are spending on; is it your more expensive pieces or the pocket friendly ones? To do this bit of arithmetic monthly, you’ll need your sales for the month and the number of orders that were placed in that month.
For example, your total sales in February were KSh100,000 which came from 10 orders. That means your AOV for that month was KSh10,000. This information can help you plan your budgets when it comes to future investment or your cost per products and expenses. So it goes without saying, the higher the figure the better.
Inventory Turnover Ratio
It’s not all about the product that’s left the store via sales. You have to look at the product that hasn’t sol yet as well because it’s still money lying around. Knowing your Inventory Turnover Ratio (ITR) will help you diagnose the health status of your fashion venture. It’s also a good way to identify if you’re overproducing a product and need to cut down ASAP. First step is to determine your Average inventory. This is used to determine the amount of stock that a business typically has on hand over a longer period of time. Because fashion is affected by seasons, there are sudden spikes and drops that would affect the overall picture. Thus the Average inventory is used.
Average Inventory = (Beginning inventory + Ending inventory) ÷ 2
The above equation is used for a single month, thus in the event you’re calculating for more than one month, accountingtools.com suggests, ‘adding together the ending inventory balances for all of the months and dividing by the number of months’ to derive the ending inventory figure you’ll use in the equation. Once that’s done, you can find out what your ITR is through:
Keep in mind that your costs of goods sold (COGS) refers to only the money spent on directly creating your product such as fabric. For example, your Bow’s COGS came to Ksh300,000, while you beginning year inventory was Ksh1 million and the ending year inventory was Ksh1.2 million. The Average inventory comes to Ksh1.1 million which makes the ITR 0.27 times. This basically means that you’re selling less than a third of your inventory aka not a good position to be in.
We know it’s a Monday so we’ll end the numbers game there. However, we recommend that you head over to the British Fashion Council website and read the “Commercializing Creativity Report”. Written by Alejandra Caro and Alessandra Basso, MBA students at the London Business School, this chronicle offers some of the best strategies for challenges often faced by fashion entrepreneurs. Designers can and are making a living from their work. But in order for you to do the same you’ll need to get out of your creative comfort zone and get your hands a little dirty in math.